Thursday, 23 September 2010

Capitalism and Free Markets

Conventional economic history has it that capitalism was a product of the sixteenth and seventeenth centuries, when the economic environment allowed the speculative investment of surplus money and the legal vehicles for joint enterprise became recognised. Long ago I debunked this in a paper that showed such investment and joint enterprise was flourishing as early as the thirteenth century - in charter boroughs. Boroughs such as Dunwich that lived outside the feudal system, governed by their merchants, developed an economy based on the exchange of money rather than on obligations of goods and labour. Sending a ship across the North Sea to trade was a risky business; the value of the ship, and of the goods she carried, was huge. So merchant ship owners spread the risk between them; they invested in their competitors, reducing their reward but also reducing their risk. In the words of Adam Smith, 'sober and frugal', and 'solid and profitable'. And the reason capitalism flourished in these little hothouses of commerce was that the charter boroughs operated free markets.David Green in today's Telegraph defends Vince Cable's condemnation of the unacceptable face of capitalism ; Cable's comments were entirely in line with positions taken by both Hayek and Adam Smith. And he has a point.

The banks and large institutional investors have been acting like irresponsible spendthrifts, greedy for the fast buck, utterly careless, morally feckless, drunk on zeros. A shipowner in Dunwich who spent his last penny loading his cog with his own trade goods to send across the North Sea, only to lose her to the waves, or pirates, lost all. He went overnight from affluence to penury, from merchant to beggar. Any suggestion that the Town should bail him out, should maintain him in his former state, would be met with derision. Yet this is exactly what we've done for the banks.

'Sober and frugal' and 'solid and profitable' are good for us all. The City spivs do us no favours; they destroy by their greed that which we have so painfully built. If they won't change, we must make them.

8 comments:

Indeed, but it's our collective fault for allowing the banks to get into a position where their failure would have serious repurcussions for everyone, shareholder or not. The "infrastructure" part of the industry must be more carefully regulated so that it doesn't blow up in our faces again. The regulators need to get involved, just as they do whenever there is a train crash.

Isn't there and argument that the problem has been (as often the case) with partial regulation.Had they been fully regulated they would have worked, albeit with stultifying lack of energy. Had they been totally unregulated they would not have had the loopholes and legal instruments open to them to get into such trouble.

"Any suggestion that the Town should bail him out, should maintain him in his former state, would be met with derision."

This is the nub, the point, the central thing we need to grasp.

We don't need to over-regulate banks; we don't need to control how much they pay their people, or how large their bonuses are: all of that is peripheral.

All we need to do is convince them - perhaps by example - that if they screw up, they themselves will become the sad guy sitting on the pavement hugging his dog to keep warm, while asking every passing stranger if they have a bit of change to spare.

Once the bankers really believe that, they'll take care of their businesses all right.

i think that WE has hit the nail on the head. i have no problem with the banks, like any other business they are tere to make a profit.... if they get it wrong they should, like any other business, go bust... focusses the mind!

The banks were (and are) one of the most heavily regulated businesses in the UK. What was wrong was the regulations were inadequate, which was primarily Brown's doing.

When Northern Rock went under neither the FSA nor the BoE knew what to do or whose responsibility it was. Nothing sensible was done for a year until RBS and HBoS went under too.

Brown specified the Bank rate by instructing the MPC to follow CPI, an index without house costs and heavily biased to import prices from China. The result was too low a Bank rate over a number of years leading to a property boom.

In America the banks were undermined by the removal of Glass-Steagall and the imposition of the CRA. Both carried out by Democrats like Clinton and Obama. The Community Re-investment Act prevented banks from expanding unless they lent mortgages to the very poor. These mortgages were bundled and sold on - and who wouldn't?

So bank failure and the 'credit crunch' (the drying up of interbank loans) were therefore largely the result of political failure. The failed UK banks contributed to their own demise of course: NR - overextended; HBoS - did not diversify out of property; RBS - vaingloriously acquired ABN. I would say: politicians - 80% to blame; banks - 20%.

Maybe David Green did give Cable support, but the Telegraph's leader certainly did not - "The joke wears thin".Neither did Alistair Osborne or Garland's cartoon.And neither have I in my own blog, for what it is worth!http://english-pensioner.blogspot.com/2010/09/vince-cable.html

Brown specified the Bank rate by instructing the MPC to follow CPI, an index without house costs and heavily biased to import prices from China. The result was too low a Bank rate over a number of years leading to a property boom.

That is certainly the way the story is often told, although despite their Wizard-of-Oz presentation, central banks are nearly always reactive; their rates follow market rates. Market rates fell globally, not just in the UK. The housing bubble was also global.

The reason market rates (and the BoE base rate which followed them) were too low was fractional reserve banking, under which the implicit or explicit guarantee of a government bailout of the banks allows long-term investment to exceed long-term savings, removing the interest rates' free-market function of matching the two. Under those conditions, long-term investment is constrained largely by speculative criteria; people mistrusted the stock markets at the time, so money entered housing markets, and people later entered in order to chase the rise in house prices.

Under a true free market in savings, where long-term investment had to match long-term savings, a surge in demand for mortgage money would have rapidly increased mortgage interest rates to the point where buying houses ceased to make sense, killing off the bubble early on.